Amkor Technology, Inc. (AMKR) Q2 2008 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen. Welcome to the Amkor Technology Inc., second quarter 2008 Earnings Call. (Operator Instructions). Before we begin this call, Amkor would like to remind you that there will be forward-looking statements made during the course of this conference call. These statements represent the current view of Amkor management and actual results could vary materially from such statements. Prior to this conference call, Amkor's second quarter earnings release was filed with SEC on Form 8-K. The earnings release, together with Amkor's other SEC filings, contain information on risk factors, uncertainties and assumptions that cause actual results to differ materially from Amkor's current expectations. I would now, like to turn the conference over to Mr. James Kim, CEO and Chairman. Please go ahead.

Thank you, and good afternoon. This is James Kim. With me today are Ken Joyce, our President and Chief Operating Officer; and Joanne Solomon, our Chief Financial Officer. During the second quarter our net sales decreased $9 million, or 1% sequentially and overall unit shipments were down 3% compared to the first quarter of 2008, which was a record first quarter. We saw units and the sales increases for flip chip and 3D packaging, as our advanced technology packages have become an increasingly important component of our mix of packaging services. This growth was more than offset by a decline in units and sales of the leadframe packages. As we look ahead, we are cautious about softness in the consumer market and global economic uncertainty. For the third quarter of 2008, we expect revenues to grow sequentially by 4% to 6%, which is below the level of our historical seasonality due to the uncertainty around current consumer demand. We believe we are well-positioned to respond to changing markets with our improved balance sheet and through our continued focus on technology, e-customer relationships, post competitive manufacturing and financial discipline. I would like to now turn the call over to Ken Joyce. As you know, Ken was appointed President of Amkor in May and also serves as Chief Operating Officer. Everyone at Amkor has great confidence in Ken, and I am pleased to welcome him back to our earnings call in this new role. Ken?

Thank you, Jim. During my first few months as President and COO, I have made a concerted effort to meet with each of our major customers, and many other leaders in the semiconductor industry to understand their needs. Many of our customer relationships were tested during the second quarter, by production disruptions we experienced as a result of our ERP implementation in the Philippines. May was a particularly challenging month for us as we lost the equivalent of almost 10 days of production capacity. We worked closely with our customers to prioritize loadings and ultimately regained their confidence. Although our normal production capabilities have since been restored, we underperformed our second quarter plan in the Philippines by approximately $19 million. Based on what I have learned while working through the implementation issues, I believe our sales could have been $10 million to $15 million higher, if we did not have the ERP disruption. During the quarter, the results across our end-markets were mixed, with pockets of strengths and weakness. Overall, we saw a sequential growth in the communications market driven by increased demand for handsets. In the consumer markets, we saw strength in digital TV and digital set-top boxes, offset by weakness in legacy gaming and other consumer products. With regard to our pricing environment, we face challenges every day. Although our overall pricing was generally stable during the second quarter, we are seeing increasing pressure, particularly for legacy semiconductor packages. We continue to differentiate ourselves based on technology and quality to help stem some of the pricing pressure. For legacy semiconductor packages, it becomes very important that we drive down our costs, to match any pricing reductions. I will now turn the call over to Joanne Solomon to review our second quarter results. Joanne?

Thank you, Ken. Gross margin for the second quarter was 23%, down from 25% in the first quarter of 2008 and 25% in the second quarter of 2007, reflecting the impact of lower than expected sales and an overall product mix of packages with higher material costs. Approximately $5 million of the sequential decline in gross profit is attributed to the $9 million reduction in second quarter sales as compared to the first quarter. Materials as a percentage of revenues increased to 39% for the second quarter, from 37% for the first quarter. This increase in material costs in part reflects an increase in purchase versus confined flip chip substrates. Looking forward to the third quarter, we expect margins to be between 23% and 24%, which includes incremental severance costs, estimated to be $10 million associated with the announced reductions in force. Regarding the fourth quarter, we expect to realize about $3 million in quarterly cost savings from these headcount reductions. Operating expenses for the second quarter were $73 million, decreasing from $79 million in the first quarter and flat as compared to the second quarter of 2007. Included in operating expenses for the second quarter 2008, was a $10 million gain from the sale of a real estate transaction. Selling, general and administrative expenses for the second quarter were $67 million, increasing from $65 million in the first quarter and $62 million in the second quarter of 2007. The sequential increase is largely attributed to the incremental costs incurred in connection with the ERP implementation and subsequent stabilization. Research and development costs for the second quarter, were 2% of revenues which is consistent with the first quarter. Given the uncertain global economic environment Jim referred to, we continue to rationalize our capital additions, especially with respect to investments in Wire Bond and tests. Where appropriate for the past two quarters, we have delayed certain capital projects and reduced their scope. We believe our overall capital intensity is tracking to approximately 14% of revenues for 2008, driven in part by the higher capital intensity and demand for wafer level processing. There is a recap of our third quarter 2008 guidance contained in our earnings release. Sales up 4% to 6% from the second quarter of 2008, gross margin between 23% and 24%, net income in the range of $0.24 to $0.28 per diluted share. Operator, we will now open this call for questions.

(Operator Instructions). Our first question is from Bill Ong. Please state your company name followed by your question.

Yes, good afternoon. From American Technology Research. Can you just talk about the inventory levels among your different end-market segments, how much is in die bank, backlog visibility, just a general sense of what is taking place in the quarter versus a year ago?

Bill, as far as the inventories in the supply chain, we are seeing some building in certain areas, clearly in the wireless. As far as the die bank inventories, once again, I think we talked in the past that it's not a statistic that is been really meaningful to us. It is not something that we track on a regular basis. The die banks, not all of our customers as you know maintain die banks, so it is not a statistic that we track.

Okay. Thank you very much.

Thank you. Our next question is from Timothy Arcuri. Please state your company name followed by your question.

Hello, this is actually Bryan Lee calling in for Tim for Citi. Couple of things from me. First off, how much of the $10 million to $15 million that you think slipped out of Q2 due to the ERP issue is being recaptured in Q3?

I do not know with respect to the $10 million to $15 million, but I would estimate somewhere in the range of $5 million. It is very hard to tell, but that would be my target.

Okay. Okay. The reason I am asking is, if the ERP issue had not impacted Q2 revenues, would you say your guidance for Q3 probably would have been, about $5 million to $10 million lower than the 7.25 midpoint that you are guiding today?

I think where we are at, Bill is, our numbers we are at $691 million for the quarter. And as we told you, we missed by $10 or $15 and I think with that, you will have to do your own calculations.

Okay, great. Then on the ASP, the pricing environment, it sounds like it is been pretty stable for you guys. Obviously, your largest rival in Taiwan reported numbers earlier this morning, and it sounded like they were talking about a bit worse pricing environment than you guys are. Can you comment first on what you expect ASPs to do here through the back half of the year and maybe why your outlook is a bit better than what your Taiwanese rivals are saying?

Well, I think, as I said in the conference call comments earlier, we are experiencing pricing pressure, especially with respect to the legacy semiconductor packages and that would be leadframe and laminate products. When we look at pricing for any one customer, it is the total portfolio of services that we offer. So you have pricing all of the time. So, I would not say that we are not experiencing pricing pressure. I think we are. I think we are managing it well, though.

Okay, great. Then last thing from me, on the margins. It looks like there is about a 50% to 60% drop due to the gross margin line here in recent quarters. How should we be thinking about this going forward with the headcount reduction you are announcing today or is most of this just offsetting some of the pricing pressure that you are seeing on the raw material side?

I think a lot of what we saw on the gross margin side was part due to the lower revenue levels that we experienced in the second quarter. As we see those revenue levels coming up, we will get better utilization of our assets. The other thing that impacted us was that shift in materials. We had the packages that have higher material content, principally flip chip, we had a real shift between those customers that consigned the substrates to us as opposed to those that we purchased. While we get a benefit for those that we purchased, that does put pressure on the margins. Also, for the second quarter we did have a smaller reduction in force in Korea, so there was a charge in there. That was about $2 million. So after you take the mix of all those events, that's how you get up to, the higher levels of margins that we are forecasting for Q3, especially when you start to add back any of the additional severance. That's a long way of saying, by the fourth quarter we should get a benefit of reductions in force of about $3 million.

Okay. And it's fair to assume that most of that if not all of that $3 million is really coming out of COGS and very little on OpEx?

There is some key to this, that is OpEx. I would assume that the majority of it is COGS. The majority is COGS. I would say 75/25.

Ex-severance charges, would you expect OpEx to trend up or will it be down in 3Q and 4Q?

With respect to operating expenses, I see SG&A staying flat to these levels. I see R&D remaining to track to the 2% level for Q3, and that is how I see operating expenses.

Okay. Thanks guys.

Thank you. Our next question is from Satya Kumar. Please state your company name followed by your question.

This is [Liz Valarie] for Satya. I'm calling from Credit Suisse. Thank you for my question. You mentioned ERP impact resulted in revenues lower by about $10 million to $15 million. If we just consider that ERP did not happen, your revenues would be about $706 million, which would still be lower than what you had previously guided which was $721 million? So, can you just reconcile why that is the case?

Well, we obviously we saw some softness versus what our projection was when we gave our guidance. That would be the reflection of the softening in demand, reflection of what is going on generally in the consumer markets worldwide.

Okay. Then, you are guiding revenues up 4% to 6%, but your gross margin guidance is flat to up a 100 bps. So, can you just talk about the pricing pressure that you are seeing or what's the reason for only a 100 bps increase in gross margins, why shouldn't gross margins go back to previous levels?

So again, consistent with the earlier answer, the pressure on the gross margins is largely because there is a severance charge included that dampens by 23% to 24%. So if you add back that severance charge, we would be at a higher level. Then, there is a shift in consigned versus purchased materials, and I think Ken has already spoken about pricing pressures.

Okay. And one last one for me. Your R&D spending is up about 50% in the last two quarters. So fiscal four quarter about 10.7%, right now it is about 15.1%. So can you talk about the increase in R&D and you mentioned that it is going to be 2% for the next quarter, but is this dollar level going to be the same going forward?

Yes, the dollar level is the same going forward. For the first quarter, we had some investments in R&D infrastructure. We had previously announced that our wafer bumping operation in North Carolina was starting to wind down operations and be more dedicated exclusively to R&D, so there is a real lift in R&D expenses because of the depreciation, and then on top of that we continue to invest in technology. So as you see growth in our revenues you are also going to see growth in R&D as well because we are investing for the future.

Okay. Thanks a lot.

Thank you. Our next question is from the line of Christopher Blansett. Please state your company name followed by your question.

JPMorgan. Looking out to the general product mix change going from the second to the third quarter, what are you guys expecting there?

Chris, the pattern's been really strong and I do not know if Ken is going to want to add something as well, but the pattern has been really strong. Now we continue to see great adoption of flip chip and 3D packaging. So I would expect those areas are going to be the same areas that we will be talking about growth in the third quarter as well.

Okay. And then, in general, although, I know your CapEx is still low versus historical terms or trends, but why move to the upper end of your long-term goal here? Why not keep it light, in light of the poor macro outlook and weakness in the sub-seasonal demand we are seeing in the second half?

Chris, as Joanne was saying, we are seeing good demand for flip chip. In connection with the flip chip, a lot of them have wafer bumps and wafer level processing services, and the capital investment is a little bit longer and certainly more expensive than traditional packaging. So that is what is responsible for that increase.

Along those lines and things like pure test equipment purchases and wire bonders in the second half will be pretty much minimal or negligible?

I wouldn't say that this is the level we have been going along. There has been no significant increases there once again in the wafer level processing area.

And then one last one. Joanne, looking at the -- just stripping out the -- do you have like a pro forma gross margin number range you are pulling to give out or you just want us to do the math?

I would prefer you all did the math. I think we have given you the pieces at this point.

Alright. Thank you.

Thank you, and our next question is from Peter Kim. Please state your company name followed by your question.

Hi, Deutsche Bank. Thanks for taking my question. I was wondering, you talked a little earlier about the consignments mix increasing where your customers are providing consignment thereby inflating your revenue numbers, but impacting your gross margin. I was wondering if your outlook for that consignment mix shift being more permanent or increasing or decreasing, if you could characterize that?

Yes, absolutely. Historically, we were running at about a 50-50 split between consigned and purchased. For the second quarter, it went more to a 25% consigned versus 75% purchased. And, the reason for the shift is as we ramped up several new customers that prefer that we purchase substrates for them, I expect for the third quarter that will be somewhere between those two. I think that is the range of possibilities that we are seeing.

Okay. And then, I wanted to just step back on the CapEx question from earlier. You said that you are still looking to invest about 14% of your revenues and your competitors are investing somewhat less than that in my calculation. And I was wondering, if you look at this investment, do you expect to realize an improvement in gross margin as a result. Is that something that you think we should model in going forward from these increased investment levels?

Some of the CapEx is definitely attributed to cost savings initiatives. I would not expect to see much in the way of margin improvement until 2009. And with respect to margin pressures of the capital investments that Ken was talking about, about 30% of that investment is based on wafer level packaging that we won't really see the demand for it until 2009, but we also won't see the depreciation expense until 2009 as well.

One last thing about legal costs. Your OpEx was higher this quarter in Q2. You attributed that to increase in legal costs, considering that your arbitration with Tessera was finalized in that quarter, that's normal. But going forward, you would expect that legal costs would come down; therefore your SG&A would come down a little bit. Could you explain why your SG&A you expect it to stay at the current levels?

Yes, absolutely. You are right. We do expect legal costs to come down in the third quarter. But we are beginning to advance our next phase of our IT modernization project, so we are expecting some increased consulting costs in the third quarter. So that would offset some of the savings that we are seeing from reduced legal costs.

Thank you.

Thank you. Our next question is from CJ Muse. Please state your company name followed by your question.

Yes, with Lehman Brothers. Thank you for taking my question. First question here is on the gross margin side. Looking beyond Q3, and as you see the positive mix shift to flip chip and other advanced packaging, how should we think about that trend exiting 2008 and going into 2009?

It is hard for me to say because it is so dependent on the mix of customers. We did see some of our larger confined materials customers have lower levels of demand for the second quarter, but we fully expect those to come back in the third quarter. So, I do believe that the 25% consigned material level will increase somewhere higher and how it ultimately falls out; we are going to have to wait and see.

Okay. And then in terms of end markets, in your prepared remarks you talked about cautious on the consumer and the global economy. Are there other end markets that you serve where you are seeing weakness and what kind of visibility do you have? Does that extend through the calendar year or is that just into weakness for Q3?

Well, as we look at the overall end markets, as we say we do see uncertainty in the consumer area. In the area of communications, particularly in wireless, we have seen actually pockets of strengths and weaknesses during the quarter for us actually mobile handsets were really very strong. So we are seeing that. There are pockets of strength in the computing area. So overall, that is what we are looking at for the next quarter out, anyway.

Great. Thank you.

Thank you. And our next question is from [Sandor Verdaraham]. Please state your company name followed by your question.

Yes, hi Deutsche Bank. Just a few questions. I want to start off with the ERP. You had issues at Philippines. Just wanted to see if you are completely behind that and secondly, how many more regions do you still have left in terms of the ERP implementation and how confident are you that we may not see a repeat of what happened at Philippines in some of these other locations where you still have the ERP implementation remaining?

Sandor, it is Ken, how are you?

Good and you?

Good, thank you. With respect to the ERP systems, we are continuing to modernize our systems, our factories in Korea and the Philippines. Taiwan and Singapore, they have already migrated to our new ERP environment. Just prior to going into the Philippines this year, last year we had a very, very successful implementation in Korea which is 50% of our operations. These are really very complex systems. We planned for these and we do the best we can. We feel confident that we have learned some lessons here from some of the issues that we faced in the Philippines. We are prepared to move forward as we migrate to our other systems.

So you said Korea and Singapore are both done?

Korea is done, the Philippines is done, Taiwan and Singapore are done. We have to do the corporate interfaces here in the United States.

Okay. Turning to a couple of other questions. You talked about weakness in consumer, yet when I look at the end market, it seems like computing has been pretty weak especially on the year-over-year basis both in Q1 and Q2, yet from an end market perspective and volume perspective, the PC desktop market seems to be holding up pretty nicely. Could you tell us what is going on with respect to your computing business as far as your end market is concerned and why we might be seeing that softness?

Yes, I think the computing is principally attributable to a major IDM. It is one customer. We do not really give out customer names. That is the principal reason for the decrease between Q2 of '07 and Q2 of '08. So it is one major IDM whose programs vary from time-to-time in the computing area and that was the major shift in those two quarters.

And finally, on the capacity utilization front, I saw that in the third quarter you are down to 73% from 80% in Q1, and when you look at Q2, what kind of utilization levels do you expect to have in Q2 and any color on why your Q2 utilization kind of dipped?

So, you are looking for utilization in Q3, Sandor? Is that it?

Yes.

It is not something we have tended to forecast in the past. I mean, it is clearly going to be higher than where we were at the 73%. When I look at that 73% utilization number that was really affected by the ERP disruption issues in the lower levels of demand that we saw for the second quarter.

Okay.

That should all recover and we will be back over the 80% level.

And finally, on the CapEx front, you seemed to have a firm number for Q3 and you have guided to the higher end of the previous range at 14% of revenue for Q4. How much flexibility do you have to get those numbers lower if as the quarter progresses you see things slowing down even further?

We have plenty of flexibility, and I think we have demonstrated that over the years and clearly over the last couple of quarters. This quarter, if you recall we guided up 140, we came in around 122. That didn't happen by accident. We ratcheted down rates based on what we saw in demand and we are going to do the same. We are closely monitoring what is going on. The demand and the capacity available and we will adjust accordingly, but we can flex relatively quickly.

Thank you.

Thank you. Our next question is from the line of [Ross Strello].

RBC Wealth Management. Hi, Ken, how are you doing?

Good, Ross, how are you?

Great, great. How many people are actually involved in the workforce reduction?

It is a fluid number at this point. We have announced the programs and some of the affected jurisdictions. We are estimating it will be north of 600.

Okay. And, with you going into a stronger time of the year with your guidance up 4% to 6% on revenues, why are you doing the workforce reduction now?

This is Jim. This was planned at the beginning of the year, it was part of our plan to increase our productivity and it is going to be a continuing effort for the future. It is not just a one-time thing. But right now, we are delayed a little bit due to the ERP issue that slipped in. Overall, this has been well planned at the beginning of the year.

Okay, great. That is the answer I was looking for. It is all involved with productivity.

Absolutely.

Okay. Then one final question; on your raw materials with what is happening in the metals, all of the raw materials costs right now, how would you describe your inventories compared to normal? Are they around normal? Do you have a lot of inventory? Are you fairly lean? Where do you stand there?

I feel like our inventory levels are at a very normal place. We do obviously carry some gold inventory, but our inventory levels are at a very consistent level.

Okay, great. That's all for me. Thank you.

Thank you.

All right, Ross thanks.

Thank you. Our next question is from the line of Eric Ruebel. Please state your company name followed by your question.

Thanks for taking my questions. Most of them have been answered. Just if I could turn to the capacity utilization one more time on the flip chip side. You take utilization in the quarter at 73% and a lot of that affected by the Philippines. I would imply from that, that flip chip utilization was a lot higher and if I kind of think about the way you add capacity for flip chip; you do that in step functional ways rather than just adding Wire Bonders. So, could you comment at all on the flip chip utilization, is that much higher?

The 73 is overall utilization, Eric, and you are right on target. The flip chip packaging utilization would be higher than that. Tied into the flip chip is your -- when we had that, we tried to get total overall turnkey services, which requires the bump, the probe and the flip chip packaging and final tests. We don't always get that, but that is what we targeted to do. So that would change the profile of overall utilization, increase test utilization, increases the packaging and also wafer bumps. So you are right on target. The flip chip is higher than the 70% overall utilization number.

Very good. And then, just one last question, at the leading edge on the R&D side. Are you seeing any adoption of any through Siliconware technologies, and could you comment on any customers that are kind of putting that into adoption?

We have. It is talked about a good deal. We do have our R&D teams focused on that. We have our wafer level processing R&D team have addressed that. I know as you were to talking to -- Joanne was talking earlier about our increased R&D expenditures. We do have a team that is spending some money looking at that, talking with our customers, talking with the foundries around the world. So, that is a very hot subject and our R&D people are looking at it.

One last question, if you could sort of frame my expectations around when Tessera could wind up?

The final oral arguments were held on June 10th, as you probably know. There is no such schedule. We do expect a decision sometime in the third quarter.

Okay. Thank you.

Thanks, Eric.

Thank you. We have a follow-up question from Christopher Blansett. Please state your company name followed by your question.

Kind of along the lines of some housekeeping, did you give out depreciation in the quarter and then just going forward over the next few quarters, your interest expenses, should we expect any changes?

On the depreciation expense, in total, the second quarter depreciation grew by $3.5 million and that includes the amortization side, as well as depreciation that's included in SG&A and R&D. So the total was $77 million. We expect that to increase probably another couple million for the third quarter. With respect to depreciation included in cost of goods sold, it tends to run around the 8% of revenue. With respect to net interest expense, we would expect it to continue at the same levels and we are still expecting overall for 2008 for net interest expense to be down about $20 million.

Alright, and then one quick one on the Forex. Is there anyway you internally estimate what your Forex expectations are for the out quarter, just to give us maybe a reference.

Yes, we take a look at it. There are obviously two components of Forex. There is the piece that hits our operating results, those that are in gross margins and SG&A, and that is principally the short Korean Won, a Philippine Peso position with respect to labor and utilities. We also have been seeing tremendous swings because of the translation of the long-term employee severance liabilities. That is what drove the additional $12 million that we saw this quarter. We do feel like that may reverse in the next quarter, but we are not currency traders. We do look to some banks with respect to how they forecast the Korean Won and we know where the Korean Won is currently trading, and we would expect maybe at this point a loss of $4.5 million, but that could turn.

Alright. Thank you. I appreciate it.

Thank you for participating in our conference call. We look forward to speaking with you again. Thank you.

Ladies and gentlemen, this concludes the Amkor Technology Inc. second quarter 2008 earnings conference call. If you would like to listen to a replay of today's conference, please dial 1800-405-2236 or 303-590-3000, followed by the pass code 11116655. AT&T would like to thank you for your participation. You may now disconnect.